Tesco's new online rival

Launched four years ago, Tesco's online shopping service was one of the dotcom success stories of the late 90s. It discovered a market that had gone untapped, and since 2001 it has been in profit, with more than 1m registered users, and 75,000 orders a week.

The key to its success was two-fold. It had first mover advantage, rapidly increasing its operation to cover 95% of the population. (Its main rival, Sainsbury's, reaches only 71% of UK households.) Second, it used a delivery model much derided at the time, but which later came to be seen as a stroke of genius: instead of building large warehouses to service its online arm, it employed pickers to go around local stores picking goods off the shelves.

Thus, it was able to get the operation off the ground quickly and cheaply. "Tesco's approach has been slightly low-tech until now. They didn't spend a lot of money on making an efficient system," says Daniel O'Boyle Kelly, senior analyst at IDC. Its competitors struggled. Somerfield closed its online arm. Safeway never launched a home delivery service. Sainsbury's, using a combination of warehouse and in-store picking, doesn't expect to be in profit until the end of the 2003/4 financial year. Iceland has 97% coverage but is coy about numbers. Asda's service is available to only 8.5m households.

But Tesco doesn't necessarily have the market sewn up. Being first off the block meant Tesco's competitors could learn from its mistakes. And there have been many. The biggest complaint has been the high number of unavailable items. "Tesco never seems to have the products in stock - the number of times they'd send everything for spag bol except the spaghetti and mince got stupid," says customer Emily Dubberley.

Ask for a product that isn't available and Tesco will substitute a replacement. Stories about inappropriate substitutions abound, however. One customer ordered bayonet-fitting light-bulbs but was given screw-threaded ones. Admittedly, it's not just a Tesco problem: Dubberley once ordered vegetarian sausages from Sainsbury's and received frozen (meat) toad-in-the-hole.

And then there's customer service. Tesco has had complaints that its orders often don't arrive within the two-hour delivery slot requested by the customer, and that its delivery staff are surly and unhelpful. So the time is ripe for a rival. Step forward Ocado, part-owned by the John Lewis Partnership and launched in January. Initially, the service, which uses Waitrose goods, was offered only in Hertfordshire; in June, it expanded into London, with a further investment of £17.75m.

Ocado has a warehouse that can process the same amount of groceries as 20 large supermarkets, and which uses route optimisation software to match resources, such as delivery vans, with demand. Managing director Nigel Robertson says Ocado provides the two things customers want from an online supermarket.

"They want low levels of substitution and on-time delivery." Ocado's substitution rate, he says, is only 2%, compared to the 15% industry standard. His claims are supported by customers.

"I've been shopping online for about two years and Ocado are the first reliable suppliers I've found," says Dubberley. "Ocado do sensible substitutions: loose potatoes instead of pre-packed, that kind of thing." Diane Burnham says Ocado has changed her life. "We were doing a big shop at the weekend, and we just don't do it any more." She forgave Ocado teething troubles with its website because its customer service people were helpful, and she appreciates the one-hour time slot for delivery. "They've only been late once, and the delivery man gave us a bottle of wine."

It's early days for Ocado. Its geographical and customer base is still small, and there are signs that the other supermarkets are tidying up their acts. Tesco claims to have cut its substitution rate by using improved technology to keep the stores full.

What about the long term? The arrival of broadband means that more and more people will shop online - suggesting there is plenty of room in the market for Tesco and competitors. Service differences are likely to smooth out, making it more likely that people will choose on the basis of price and brand loyalty. Tesco's status as first to market has won it a lot of customers. But if it's still going to lead the field in five years' time, it will have to work a lot harder.